Questions & Answers p2

Test your understanding 1 – Cookie

Cookie, a company, prepares its financial statements in accordance with International Financial Reporting Standards. It has investments in two other companies, Biscuit and Cracker. The statements of financial position of all three companies as at 30 April 20X4 are presented below:

	Cookie	Biscuit	Cracker
Non-current assets	$m	$m	$m
Non-current assets
Property, plant and equipment	80	85	67
Investments	101	10	−
	–––––	–––––	–––––
Current assets	181	95	67
Current assets
Inventories	19	6	25
Trade receivables	17	13	33
Cash and cash equivalents	22	3	14
	–––––	–––––	–––––
Total assets	239	117	139
Equity and liabilities	–––––	–––––	–––––
Equity and liabilities
Share capital ($1)	21	10	20
Other components of equity	50	–	20
Retained earnings	105	79	43
	–––––	–––––	–––––
Total equity	176	89	83
Non-current liabilities	40	10	18
Current liabilities	23	18	38
	–––––	–––––	–––––
Total equity and liabilities	239	117	139
	–––––	–––––	–––––

The following notes are relevant to the preparation of the consolidated financial statements:

On 1 May 20X3, Cookie acquired 55% of the ordinary shares of Biscuit. Consideration was in the form of cash and shares. The cash consideration of $30 million has been recorded in the accounts of Cookie but no entries have been made for the 5 million shares issued. These had a fair value of $4.50 each on 1 May 20X3. The retained earnings of Biscuit at this date were $70 million.

The fair value of the net assets of Biscuit at the acquisition date was $95 million. The difference between the fair value and carrying amount of the net assets was due to a brand that was not recognised by Biscuit. This brand was estimated to have a remaining useful economic life of 5 years. The fair value of the non-controlling interest in Biscuit at acquisition was $45 million.

On 1 May 20X3, Cookie spent $56 million to acquire 70% of the ordinary shares of Cracker. On this date, Cracker had retained earnings of $30 million and other components of equity of $20 million. On 1 November 20X3, Cookie spent another $15 million in order to increase its holding to 90% of Cracker’s ordinary shares. Cookie elected to measure the non-controlling interest in Cracker using the share of net assets method.

During the year, Cookie sold goods to Biscuit for $4 million making a profit of $2 million. This sale was made on credit and the invoice has not yet been settled. One quarter of the goods remain in the inventory of Biscuit at the year end.

There has been no impairment in respect of the goodwill arising on the acquisition of Cracker. At the year end, it was estimated that the recoverable amount of the net assets of Biscuit was $107 million.

The investments held by Biscuit relate to equity shares that have been designated as fair value through profit and loss. They were purchased during the current year and are currently held at cost. At 30 April 20X4, these shares had a fair value of $15 million.

Included in the non-current liabilities of Cookie is a loan denominated in another currency, the Dinar (DN). The loan, for DN10 million, was received on 1 August 20X3 and correctly recorded at the spot rate. No other entries have been posted. The following exchange rates are relevant:

	DN:$1
1 August 20X3	2.3:1
30 April 20X4	2.6:1

Included in the property, plant and equipment of Cookie is an item of specialised plant which was constructed internally. Construction began on 1 May 20X3. The asset was recorded at a cost of $15 million and was attributed a useful economic life of five years. A breakdown of the cost is as follows:

	$m
Materials for construction	7.3
Directly attributable labour	2.9
Testing of machine	0.6
Training staff to use machine	0.5
Allocated general overheads	3.7
	–––––

15.0

–––––

The plant was available for use on 1 November 20X3 and was depreciated from this date.

During the year, Cookie started selling goods under warranty. No warranty provision has been accounted for. Cookie will repair goods under warranty for any manufacturing defects that become apparent within a year of purchase. If all items under warranty at 30 April 20X4 developed minor defects, then the total cost of repairs would be approximately $6 million. If all items under warranty developed major defects, then the total cost of repairs would be approximately $14 million. The directors of Cookie estimate that 7% of items under warranty will develop minor defects within the warranty period and that 4% of items under warranty will develop major defects within the warranty period.

Required:

Prepare the consolidated statement of financial position for the Cookie Group as at 30 April 20X4.

Test your understanding 2 – Pineapple

Pineapple is a public limited company which has investments in a number of other companies. The draft statements of profit or loss for the year ended 30 September 20X3 are presented below:

	Pineapple	Strawberry	Satsuma	Apricot
	$000	$000	$000	$000
Revenue	9,854	3,562	2,435	6,434
Cost of sales	(5,432)	(2,139)	(945)	(3,534)
	–––––––	–––––––	–––––––	–––––––
Gross profit	4,422	1,423	1,490	2,900
Administrative	(1,432)	(400)	(523)	(600)
expenses
Distribution	(402)	(324)	(237)	(254)
costs	–––––––	–––––––	–––––––	–––––––
Profit from	2,588	699	730	2,046
operations
Investment	386	15	34	135
income
Finance costs	(246)	–	(35)	–
	–––––––	–––––––	–––––––	–––––––
Profit before	2,728	714	729	2,181
taxation
Taxation	(486)	–	(161)	(432)
	–––––––	–––––––	–––––––	–––––––
Profit after tax	2,242	714	568	1,749
	–––––––	–––––––	–––––––	–––––––

Movements in the retained earnings of each company for the year ended 30 September 20X3 are presented below:

	Pineapple	Strawberry	Satsuma	Apricot
	$000	$000	$000	$000
1 October 20X2	5,645	1,325	2,342	3,243
Total	2,242	714	568	1,749
comprehensive
income for the
period
Dividends	–	(400)	–	–
	–––––––	–––––––	–––––––	–––––––
30 September	7,887	1,639	2,910	4,992
20X3	–––––––	–––––––	–––––––	–––––––

The following notes are relevant to the preparation of the group financial statements.

On 1 October 20X2, Pineapple purchased 80% of Strawberry’s 1 million $1 ordinary shares. It is the group’s policy to measure the non-controlling interest at fair value at the date of acquisition. At 1 October 20X2, the balance on Strawberry’s retained earnings was $1,325,000. The fair value of Strawberry’s net assets was deemed to be $4,000,000. The excess in the fair value of the net assets over their carrying amounts is due to a factory building with a remaining useful life at the acquisition date of 40 years.

Pineapple acquired 70% of Satsuma’s 2 million $1 ordinary shares several years ago for cash consideration of $4,900,000. At the acquisition date, retained earnings of Satsuma were $2,045,000 and the fair value of the non-controlling interest was $1,600,000. On 31 March 20X3, Pineapple sold its entire shareholding in Satsuma for $5,600,000. Goodwill arising on the acquisition of Satsuma was impaired by 40% in the year ended 30 September 20X2. Satsuma is geographically distinct from the rest of the Pineapple group and therefore the disposal should be presented as a discontinued operation.

On 30 June 20X3, Pineapple acquired 30% of the ordinary shares in Apricot. At 30 June 20X3, it was deemed that the fair value of a building owned by Apricot exceeded its carrying amount by $1,600,000. The remaining useful life of the building was 40 years at the acquisition date.

On 1 October 20X2, Pineapple sold goods to Strawberry for $400,000. All of these had been sold to third parties by 30 September 20X3. On 1 August 20X3, Apricot sold inventory to Pineapple making a profit of $100,000. By 30 September 20X3, one fifth of these goods have been sold to third parties by Pineapple.

Impairment testing on 30 September 20X3 revealed that goodwill arising of the acquisition of Strawberry was impaired by $300,000, and that the investment in Apricot was impaired by $50,000.

Goodwill impairments should be presented in administrative expenses.

On 1 October 20X2, Pineapple made an interest free loan of $1,500,000 to Blueberry, a key supplier, who was in financial difficulties. This loan is repayable on September 20X6. If the supplier had borrowed the money from a bank, they would have been charged annual interest of 12%. Pineapple has recorded the cash outflow and a corresponding financial asset at $1,500,000. No other accounting entries have been made, except to correctly record the required loss allowance.

On 30 June 20X3, Pineapple sold a new product to a customer for $500,000 in cash and recognised the revenue in full. The terms of the sale indicate that Pineapple must offer technical support to the customer over the next 24 months. Pineapple usually charges $3,000 per month for technical support.

Pineapple set up a defined contribution pension scheme on 1 October 20X2. Pineapple must make annual contributions into the scheme equivalent to 5% of employee salaries for that 12 month period. For the year ended 30 September 20X3, employee salaries were $900,000. Pineapple has paid $30,000 into the pension scheme in the current year and recognised this as an administrative expense.

Strawberry has recently returned to profitability after several years of making losses. Strawberry correctly recognised no deferred tax in the prior year financial statements in respect of tax adjusted losses due to high levels of uncertainty in forecasting future profits. At 30 September 20X3, the tax allowable losses of Strawberry are $500,000 and it is firmly believed that these will be relieved against Strawberry’s taxable profits in the next accounting period. No deferred tax entries have been posted in respect of these losses in the current year. Strawberry currently pays tax at 22% but, prior to the year end, the government announced that the tax rate will fall to 20% next year. All other deferred tax issues in the Pineapple group should be ignored.

Required:

Prepare the consolidated statement of profit or loss for the Pineapple Group for the year ended 30 September 20X3.

Test your understanding 3 – Vinyl

Vinyl has investments in CD and Tape. CD is located overseas and prepares its individual statements using the Mark (MK). The presentation currency of the Vinyl group is the dollar ($). The statements of financial position of Vinyl, CD and Tape as at 30 September 20X4 are presented below:

	Vinyl	CD	Tape
Non-current assets	$m	MKm	$m
Non-current assets
Property, plant and	350	290	160
equipment
Investment properties	10	–	–
Investments in subsidiaries	400	–	–
Financial assets	21	–	–
	–––––	–––––	–––––
Current assets	781	290	160
Current assets
Inventories	49	45	37
Trade receivables	76	46	49
Cash and cash equivalents	52	38	23
Total assets	–––––	–––––	–––––
Total assets	958	419	269
Equity and liabilities	–––––	–––––	–––––
Equity and liabilities
Equity capital	65	76	79
($1/MK1 shares)
Retained earnings	501	275	101
Other components of equity	50	–	6
	–––––	–––––	–––––
Non-current liabilities	616	351	186
Non-current liabilities
Loans	200	15	24
Defined benefit deficit	50	–	–
Current liabilities	92	53	59
Total equity and liabilities	–––––	–––––	–––––
Total equity and liabilities	958	419	269
	–––––	–––––	–––––

The following notes are relevant to the preparation of the consolidated financial statements:

Vinyl acquired 75% of the ordinary shares in CD on 1 October 20X3 for MK360 million. The fair value of the non-controlling interest at the acquisition date was MK90 million and the retained earnings of CD were MK210 million. There were no other components of equity. The fair value of the net assets of CD approximated their carrying amounts with the exception of a brand. This brand was not recognised by CD but Vinyl estimates that it had a fair value of MK10 million at the acquisition date. The brand was deemed to have an indefinite useful economic life.

Vinyl acquired 80% of the share capital of Tape on 1 October 20X0 for $100 million. At the acquisition date, the retained earnings of Tape were $19 million and other components of equity were $1 million. The non-controlling interest in Tape was measured using the share of net assets method. The fair value of the net assets of Tape at the acquisition date were $110 million. The excess of the fair value over the carrying amount of the net assets was attributable to non-depreciable land.

The goodwill of CD and Tape was tested for impairment at 30 September 20X4. There was no impairment relating to CD. The recoverable amount of the net assets of Tape was $201 million. There have been no impairments before this date.

It is the group’s policy to measure investment properties at fair value. At 30 September 20X4, Vinyl’s investment properties were valued at $14 million. This revaluation has not yet been accounted for.

The only entry posted in the year for Vinyl’s defined benefit pension scheme is the cash contributions paid into the scheme by Vinyl of $20 million. The following information relates to Vinyl’s pension scheme for the current financial year:

Discount rate at 1 October 20X3	5%
Current and past service costs	$22m
Pension benefits paid during the year	$5m
Present value of the obligation at 30	$179m
September 20X4	$120m
Fair value of the plan assets at 30	$120m
September 20X4

Included within Vinyl’s loan balance are the proceeds from the issue of convertible bonds on 30 September 20X4. On this date, Vinyl issued 500,000 $100 4% convertible bonds at par. Interest is payable annually in arrears. These bonds will be redeemed at par for cash on 30 September 20X7, or are convertible into 75,000 ordinary shares. The interest rate on similar debt without a conversion option is 9%.

The financial assets of Vinyl represent the amount paid on 1 October 20X3 to acquire redeemable preference shares in another company, which were classified to be measured at amortised cost. The effective rate of interest is 14.6%. Vinyl has received interest from these investments of $1.3 million, which has been recognised in profit or loss. Vinyl has not yet accounted for a loss allowance on these preference shares. It has calculated that the loss allowance required is $0.2 million.

The following exchange rates are relevant:

	MK to $1
1 October 20X3	1.2
30 September 20X4	1.7
Average rate for the year to 30 September	1.4
20X4

Required:

Prepare the consolidated statement of financial position for the Vinyl Group as at 30 September 20X4.

Test your understanding 4 – Frank

The following financial statements relate to the Frank Group:

Consolidated statement of financial position as at 30 September 20X4 (with comparatives)

	20X4	20X3
	$m	$m
Non-current assets
Property, plant and equipment	221	263
Goodwill	75	142
Investment in associates	204	103
Investment properties	82	60
	––––––	–––––
	582	568
Current assets
Inventories	256	201
Trade and other receivables	219	263
Cash and cash equivalents	103	42
	––––––	–––––
Total assets	1,160	1,074
	––––––	–––––

Equity and liabilities
Share capital	122	102
Retained earnings	64	24
Other components of equity	59	30
	–––––	–––––
	245	156
Non-controlling interest	104	87
	–––––	–––––
Non-current liabilities	349	243
Non-current liabilities
Loans	163	152
Deferred tax	44	33
Current liabilities
Trade and other payables	524	486
Income tax payable	23	12
Overdraft	57	148
Total equity and liabilities	–––––	–––––
Total equity and liabilities	1,160	1,074
	–––––	–––––

Consolidated statement of profit or loss and other comprehensive income for the year ended 30 September 20X4

	$m
Revenue	1,423
Cost of sales	(1,197)
	––––––
Gross profit	226
Operating expenses	(150)
	––––––
Profit from operations	76
Share of profit of associate	21
Profit on disposal of subsidiary	3
Finance cost	(12)
	––––––
Profit before tax	88
Income tax expense	(19)
	––––––
Profit for the period	69
	––––––

Other comprehensive income – items that will not be reclassified to
profit or loss
Gain on revaluation of property, plant and equipment	50
Income tax on items that will not be reclassified	(10)
	–––
Total comprehensive income	109
Profit attributable to:	–––
Profit attributable to:
Equity holders of the parent	43
Non-controlling interests	26
Profit for the period	–––
Profit for the period	69
Total comprehensive income attributable to:	–––
Total comprehensive income attributable to:
Equity holders of the parent	73
Non-controlling interests	36
Total comprehensive income for the period	–––
Total comprehensive income for the period	109
	–––

The following information is relevant to the Frank group:

Machinery with a carrying amount of $12m was disposed of for cash proceeds of $10m. Depreciation of $52m has been charged to operating expenses in the statement of profit or loss. As a result of a revaluation of Frank’s factories during the year, a transfer has been made within equity for excess depreciation of $1m. Included in trade and other payables at the reporting date is $2m (20X3: $nil) that relates to property, plant and equipment purchased during the reporting period.

Frank received a government grant of $3m in cash during the reporting period to help it fund the acquisition of a new piece of specialised machinery needed for its production process. The machinery was purchased during the year. Frank accounts for capital grants using the ‘netting off’ method.

Investment properties are accounted for at fair value. New investment properties were purchased during the period for $14m in cash.

During the reporting period, the Frank Group disposed of some of its shares in Chip. Frank held 90% of the ordinary shares in Chip before the disposal and 40% of the shares after the disposal (leaving it with significant influence). The Frank group received cash proceeds from the sale. The profit on disposal of $3m has been correctly calculated and credited to the statement of profit or loss. The fair value of the interest in Chip retained was $32m. Goodwill and the non-controlling interest at the disposal date were $40m and $4m respectively.

A breakdown of Chip’s net assets at the date of the share disposal is provided below:

	$m
Property, plant and equipment	81
Trade and other receivables	32
Cash and cash equivalents	6
Loans	(30)
Trade and other payables	(55)
	––––
Net assets at disposal date	34
	––––

During the period, $65m in cash was spent on investments in associates.

Finance costs include a $2m loss on the retranslation of a loan that was denominated in sterling (£). All other finance costs were paid in cash.

Required:

Prepare a consolidated statement of cash flows using the indirect method for the Frank group for the year ended 30 September 20X4 in accordance with IAS 7 Statement of Cash flows.

Note: the notes to the statement of cash flows are not required.

Test your understanding 5 – Sunny Days

Sunny Days is an entity that breeds and matures beef cattle for sale. It prepares its financial statements in accordance with International Financial Reporting Standards and has a year end of 30 September 20X4. The directors need help with a number of unresolved accounting issues that are detailed below.

In the financial statements for the year ended 30 September 20X3 Sunny Days reported biological assets of $1.8 million. Cattle with a carrying amount of $0.1 million died during the year ended 30 September 20X4 and Sunny Days sold cattle with a carrying amount of $0.4 million. During the current year, the company purchased new cattle and correctly recognised it at a value of $0.8 million. This was partly funded by an unconditional grant of $0.2 million from a local government agency.

Questions & Answers

Sunny Days does not have the information available to identify the principal market for its cattle. Details of the prices that Sunny Days could obtain for its entire herd at the two markets available to it at the reporting date are provided below:

	Market 1 Market 2
Estimated selling price ($m)	2.6	2.8
Cost of transporting cattle to market ($m)	0.1	0.4
Costs to sell (as % of selling price)	0.5%	0.5%

The farmland used by Sunny Days to rear its cattle was purchased for $3 million on 1 October 20X2 but was revalued to $3.2 million on 30 September 20X3. Due to declining property prices in the area, the land was deemed to have a fair value of $2.7 million as at 30 September 20X4.

(12 marks)

On 1 January 20X4, the government announced new legislation which made some of Sunny Days’ farming methods illegal. These laws became effective on 1 September 20X4. Due to short term cash flow difficulties, Sunny Days has not yet started to comply with the new legislation. It is estimated that the cost of compliance will be approximately $0.8 million. The government has said that fines for non-compliance are $0.1 million per month and will be strictly enforced.

The directors of Sunny Days wish to know how to account for the above costs as well as any resulting deferred tax impact. Fines are not a tax allowable expense. Sunny Days pays tax at a rate of 20%.

(5 marks)

Sunny Days enters into a contract with a supplier to use a specific retail unit (Unit 5A) for a period of five years. Unit 5A is part of a larger retail space owned by the supplier. Sunny Days will use the retail unit to sell farm produce to the general public.

During the five year period, the supplier can force Sunny Days to relocate to one of the other retail units. The terms of the contract state that the supplier would have to pay all of Sunny Day’s relocation costs, and make a payment to compensate for the inconvenience. The supplier would only benefit from moving Sunny Days if a larger retailer wished to move into Unit 5A and if they were willing to commit to using this space for more than five years. This is thought to be possible, but unlikely.

Sunny Days must open and operate Unit 5A during the hours when the larger retail space is open. However, Sunny Days can sell whatever products it wishes, at whatever prices it determines. The supplier will provide cleaning and security services.

Sunny Days will make fixed quarterly payments to the supplier. Sunny Days must also make an annual variable payment, calculated as a percentage of the revenue generated by Unit 5A.

The directors of Sunny Days require advice on whether this contract contains a lease.

(6 marks)

Required:

Discuss the accounting treatment of the above transactions in the financial statements of Sunny Days for the year ended 30 September 20X4.

Note: the mark allocation is shown against each of the three events above.

Professional marks will be awarded for the clarity and quality of presentation and discussion.

(2 marks)

(Total: 25 marks)

Test your understanding 6 – Coffee

Coffee is a company with a reporting date of 30 September 20X4. Its financial statements are prepared in accordance with International Financial Reporting Standards. There are a number of unresolved accounting issues, which are detailed below.

The financial controller of Coffee was appointed during the current reporting period. She is concerned that some of the payments made this year are significantly larger than the amounts that were provided and accrued for. The two largest discrepancies are detailed below:

– Legal experts had previously advised Coffee that it would probably be found not liable in a court case concerning breaches in employee health and safety legislation. As such, a contingent liability was disclosed in the financial statements for the period ended 30 September 20X3. However, on 1 July 20X4, Coffee was found liable and was ordered to pay damages of $2 million.

Questions & Answers

– In its financial statements for the year ended 30 September 20X3, Coffee provided for income tax payable of $3 million. However, in January 20X4, Coffee’s records were inspected by the tax authorities and a number of errors were discovered. The tax authorities recommended that Coffee improve its controls and training to prevent such mistakes from happening again. Coffee was not levied with any fines but the authorities deemed that the correct amount of tax payable on profits earned in the period ended 30 September 20X3 was $4 million. Coffee paid this in July 20X4.

Coffee requires advice as to the correct accounting treatment of these two events.

(6 marks)

Coffee makes a number of loans to its customers. The interest rate on these loans is at a market rate. Within the first 12 months, Coffee sells these loan assets to another company called Tea. Tea, which is a subsidiary of Coffee, holds the loans until maturity.

At the period end, Coffee holds loan assets that it has yet to sell to Tea. Coffee wishes to know the accounting treatment of these loan assets in both its individual and group financial statements.

(8 marks)

At the end of the reporting period, Coffee bought 200 kg of gold bullion for $4 million in cash. Gold bullion is traded on an active market and can be bought and sold instantly. The fair value of gold bullion changes erratically, and Coffee made the investment with the intention of trading it at a profit in the short-term.

Coffee is unsure whether the $4 million holding of gold bullion should be classified as cash and cash equivalents in its statement of cash flows.

(4 marks)

On 1 October 20X3, Coffee spent $2 million on acquiring a customer list that would provide benefits to the business for 18 months. Coffee has used its own knowledge and expertise to enhance the customer list, and believes that this enhanced list will bring it benefits indefinitely. The directors estimate that, at the reporting date, the original list has a fair value of approximately $1.5 million and that the enhanced list has a fair value of approximately $5 million.

Coffee requires advice as to the correct accounting treatment of the customer list.

(5 marks)

Required:

Discuss the correct accounting treatment of the above transactions for the year ended 30 September 20X4.

Note: the mark allocation is shown against each of the four events above.

Professional marks will be awarded for the clarity and quality of presentation and discussion.

(2 marks)

(Total: 25 marks)

Test your understanding 7 – Bath

Bath is a public limited company with a reporting date of 30 September 20X4. Its financial statements are prepared in accordance with International Financial Reporting Standards. There are a number of unresolved accounting issues, which are detailed below.

The directors of Bath have identified a number of operating segments. Details of these are provided below:

	Total	External	Total	Profit/
	revenue	revenue	assets	(loss)
	$m	$m	$m	$m
Delivery	304	281	215	(10)
services
Vehicle hire	217	96	94	62
Removal	51	46	173	14
services
Vehicle repairs	22	14	6	8
Road rescue	15	15	8	3
	–––––	–––––	–––––	–––––
	609	452	496	77
	–––––	–––––	–––––	–––––

The segments all earn different gross profit margins and, accordingly, Bath has concluded that they exhibit different economic characteristics.

Questions & Answers

Bath requires advice as to which of the segments are reportable in its operating segments disclosure note. For this purpose, information provided in parts (b), (c) and (d) should be ignored.

(6 marks)

Bath’s road rescue division was launched in the current financial year. Customers are charged an annual upfront fee. If the customer’s vehicle breaks down during the following 12 months, Bath will send one of its mechanics out to fix or recover it.

The finance director of Bath has noticed that the vast majority of the road rescue customers did not require any breakdown assistance during the year. As such, he is proposing to recognise revenue upon receipt of the annual fee.

(5 marks)

Bath purchased a new office building on 1 October 20W4 for $20 million and this was attributed a useful economic life of 50 years. On 30 September 20X4, the decision was made to sell the office building. At this date, the fair value was $17 million and costs to sell were estimated to be $0.1 million. The building was immediately marketed for sale at $17 million and it was expected that the sale would occur within 12 months.

In October 20X4, interest rates rose dramatically leading to a sharp decline in the property market. At 31 October 20X4, it was estimated that the fair value of the building was $13 million but Bath has not reduced the advertised sales price of the building.

Bath wishes to know the correct accounting treatment of the office building in the period ended 30 September 20X4.

(6 marks)

During the reporting period, Bath purchased an investment in the shares of Bristol for $16 million and made a designation to measure them at fair value through other comprehensive income. Bath received dividends of $3 million during the reporting period. At the reporting date, the quoted price of the shares was $20 million and the present value of the estimated dividends that Bath will receive over the next 5 years was $18 million.

Bath pays income tax at a rate of 25%. The tax base of the investment in shares is based on historical cost. Since there are no plans to sell the shares, Bath believes that it would be misleading to account for any related deferred tax effects.

Bath requires advice about the accounting treatment of the investment in the shares of Bristol for the period ended 30 September 20X4.

(6 marks)

Required:

Discuss the correct accounting treatment of the above transactions for the year ended 30 September 20X4.

Note: the mark allocation is shown against each of the four events above.

Professional marks will be awarded for the clarity and quality of presentation and discussion.

(2 marks)

(Total: 25 marks)

Test your understanding 8 – Arc

Arc owns 100% of the ordinary share capital of Bend and Curve. All ordinary shares of all three entities are listed on a recognised exchange. The group operates in the engineering industry, and are currently struggling to survive in challenging economic conditions. Curve has made losses for the last three years and its liquidity is poor. The view of the directors is that Curve needs some cash investment. The directors have decided to put forward a restructuring plan as at 30 June 20X1. Under this plan:

Bend is to purchase the whole of Arc’s investment in Curve. The purchase consideration is to be $105 million payable in cash to Arc and this amount will then be loaned on a long-term unsecured basis to Curve; and

Bend will purchase land and buildings with a carrying amount of $15 million from Curve for a total purchase consideration of $25 million. The land and buildings has a mortgage outstanding on it of $8 million. The total purchase consideration of $25 million comprises both ten million $1 nominal value non-voting shares issued by Bend to Curve and the $4 million mortgage liability which Bend will assume; and

Curve had also entered into a lease obligation on 1 July 20X0 for an asset with a useful economic life of six years. The present value of the lease payments at that date was $3 million, and the implicit rate of interest associated with the lease obligation was 10.2%. The lease required that annual payments in arrears of $700,000 must be

Questions & Answers

made. No entries had been made in respect of the lease in the draft financial statements of Curve; and

A dividend of $25 million will be paid from Bend to Arc to reduce the accumulated reserves of Bend.

The draft statements of financial position of Arc and its subsidiaries at 30

June 20X1 are summarised below:

	Arc	Bend	Curve
Non-current assets:	$m	$m	$m
Non-current assets:
Tangible non-current assets	500	200	55
Cost of investment in Bend	150
Cost of investment in Curve	95
Current assets	125	145	25
	–––––	–––––	–––––
	870	345	80
Equity and liabilities	–––––	–––––	–––––
Equity and liabilities
Ordinary share capital	100	100	35
Share premium			8
Retained earnings	720	230	5
	–––––	–––––	–––––
Non-current liabilities:	820	330	48
Non-current liabilities:
Long-term loan	5		12
Current liabilities:
Trade payables	45	15	20
	–––––	–––––	–––––
	870	345	80
	–––––	–––––	–––––

As a result of the restructuring, some of Bend’s employees will be made redundant. Based upon a detailed plan, the costs of redundancy will be spread over three years with $2.08 million being payable in one year’s time, $3.245 million payable in two years’ time and $53.375 million in three years’ time. The market yield of high quality corporate bonds is 4%. The directors of Arc consider that, based upon quantification of relevant and reliable data at 30 June 20X1, it will incur additional restructuring obligations amounting to $3 million.

Required:

Prepare the individual entity statements of financial position after the proposed restructuring plan.

(13 marks)

Discuss the key implications of the proposed plans, in particular whether the financial position of each company has been improved as a result of the reorganisation.

(5 marks)

Professional marks will be awarded in part (b) for clarity and expression of your discussion.

(2 marks)

(Total: 20 marks)

Test your understanding answers

Test your understanding 1 – Cookie

Consolidated statement of financial position for the Cookie Group as at 30 April 20X4

	$m
Property, plant and equipment ($80 + $85 + $67 – $4.2	228.2
(W9) + $0.4 (W9))
Goodwill ($1 + $7) (W3)	8.0
Other intangible assets ($15 – $3) (W2)	12.0
Investments ($10 + ($15 – $10))	15.0
	–––––
	263.2
Inventories ($19 + $6 + $25 – $0.5 (W7))	49.5
Trade receivables ($17 + $13 + $33 – $4 (W7))	59.0
Cash and cash equivalents ($22 + $3 + $14)	39.0
	–––––
Total assets	410.7
	–––––
Share capital ($21 + $5 (W3))	26.0
Other components of equity (W5)	67.8
Retained earnings (W5)	115.9
	––––––
	209.7
Non-controlling interest (W4)	57.6
	––––––
	267.3
Non-current liabilities ($40 + $10 + $18 – $0.5 (W8))	67.5
Current liabilities ($23 + $18 + $38 – $4 (W7) + $1 (W10))	76.0
	––––––
	410.7
	––––––

(W2) Net assets
	Acquisition	Reporting date
Biscuit	$m	$m
Biscuit
Share capital	10	10
Retained earnings	70	79
Investments ($15 – $10)	–	5
Brand (bal. fig)	15	15
Excess amortisation	–	(3)
(($15/5) × 1 year)	––––	––––
	––––	––––
	95	106
	––––	––––

	Acquisition	Reporting date
Cracker	$m	$m
Cracker
Share capital	20	20
Other components	20	20
Retained earnings	30	43
	––––	––––
	70	83
	––––	––––
(W3) Goodwill
Biscuit		$m
Cash consideration		30.0
Share consideration (5m × $4.5)		22.5
FV of NCI at acquisition		45.0
FV of net assets at acquisition (W2)		(95.0)
		––––––
Goodwill at acquisition		2.5
Impairment (W6)		(1.5)
		––––––
Goodwill at reporting date		1.0
		––––––

The share consideration has not been accounted for. In the above calculation, $22.5m is being debited to goodwill. Adjustments will need to be made to share capital for $5m (5m shares × $1 nominal) and to other components of equity for $17.5m (5m shares × ($4.5 – $1.0)).

Cracker	$m
Consideration	56.0
NCI at acquisition (30% × $70) (W2)	21.0
FV of net assets at acquisition (W2)	(70.0)
	–––––
Goodwill	7.0
	–––––

Remember that goodwill is calculated on the date control is achieved. It is not recalculated if further shares are purchased.

(W4) Non-controlling interest
	$m
Biscuit NCI at acquisition (W3)	45.0
45% of Biscuit’s post-acquisition net assets	4.95
(45% × ($106 – $95)) (W2)
Cracker NCI at acquisition (W3)	21.0
30% of Cracker’s post-acquisition net assets between 1 May	1.95
20X3 and 1 November 20X3
(30% × (($83 – $70) × 6/12)) (W2)	0.65
10% of Cracker’s post-acquisition net assets between 1	0.65
November 20X3 and 30 April 20X4
(10% × (($83 – $70) × 6/12)) (W2)
Goodwill impairment (W6)	(0.7)
Increase in ownership (W11)	(15.3)
	––––

57.6

––––

(W5) Group reserves

Retained earnings

100% Cookie

55% of Biscuit’s post acquisition profits

(55% × ($106 – $95)) (W2)

70% of Cracker’s post-acquisition retained earnings between

1 May 20X3 and 1 November 20X3

(70% × (($83 – $70) × 6/12)) (W2)

90% of Cracker’s post-acquisition retained earnings between

1 November 20X3 and 30 April 20X4

(90% × (($83 – $70) × 6/12)) (W2)

Goodwill impairment (W6)

PURP (W7)

Loan retranslation gain (W8)

PPE capital expenditure error (W9)

PPE depreciation error (W9)

Provision (W10)

105.0

6.05

4.55

5.85

(0.8)

(0.5)

0.5

(4.2)

0.4

(1.0)

––––

115.9

––––

Other components of equity
	$m
100% Cookie	50.0
Share issue (W3)	17.5
Increase in ownership (W11)	0.3
	––––
	67.8
	––––
(W6) Goodwill impairment – Biscuit
	$m
Year-end net assets (W2)	106.0
Goodwill (W3)	2.5
	––––
	108.5
Recoverable amount	(107.0)
	––––
Impairment	1.5
	––––

Under the full goodwill method, this impairment must be allocated between the group and the NCI based on their shareholdings.

Group share: 55% × $1.5m = $0.8m (W5)

NCI share: 45% × $1.5m = $0.7m (W4)

(W7) Intra-group trading

There has been trading between Cookie and Biscuit. The profit remaining in inventory of $0.5m ($2m × 25%) must be eliminated:

Dr Retained earnings (W5)	$0.5m
Cr Inventories	$0.5m

The invoice for the sales transaction remains outstanding. Therefore, the intra-group receivable and payable must be eliminated:

Dr Payables	$4.0m
Cr Receivables	$4.0m

(W8) Loan

The loan would have been initially recorded at $4.3m (DN10m/2.3).

As a monetary liability, it must be retranslated at the year end using the closing rate. This will result in a liability of $3.8m (DN10m/2.6).

The loan therefore needs to be reduced by $0.5m ($4.3m – $3.8m)

with a gain of $0.5m being recorded in profit or loss.

Dr Non-current liabilities	$0.5m
Cr Retained earnings (W5)	$0.5m

(W9) Plant

Per IAS 16, general overheads and training are not allowed to be included within the cost of property, plant and equipment. Therefore $4.2m ($3.7m + $0.5m) should be written off to profit or loss.

Dr Retained earnings (W5)	$4.2m
Cr PPE	$4.2m

As a result of the error above, the depreciation charge for the year will be incorrect.

The depreciation charged on this asset will have been $1.5m ($15m/5 years × 6/12). The depreciation that should have been charged is $1.1m (($15m – $4.2m)/5 years × 6/12). Depreciation must therefore be reduced by $0.4m.

The correcting entry is:
Dr PPE	$0.4m
Cr Retained earnings (W5)	$0.4m

(W10) Provision

An obligation exists for Cookie to repair units that develop defects and that are still under warranty. Per IAS 37, where a provision involves a large population of items, the expected value of the outflow should be determined.

The expected value of the cost of the repairs is:
($6m × 7%) + ($14m × 4%) = $1.0m
The entry for this is:
Dr Retained earnings (W5)	$1.0m
Cr Provisions	$1.0m

(W11) Increase in ownership

Cookie obtained control over Cracker on 1 May 20X3.

On 1 November 20X3, Cookie increases its holding of shares. Goodwill is not recalculated and no gain or loss arises. Instead, this is deemed to be a transaction within equity.

There will be a decrease in the NCI. The difference between the consideration paid and the decrease in the NCI is taken to other components of equity.

	$m
Decrease in NCI (W12)	15.3
Cash paid	(15.0)
	––––
Increase in shareholders’ equity	0.3
	––––

(W12) Decrease in NCI

The NCI in Cracker has decreased from 30% to 10%, a decline of two-thirds.

The NCI in Cracker before the share purchase was $22.95m ($21.0 m + $1.95m (W4)). The decrease in the NCI is therefore $15.3m (2/3 × $22.95m).

Test your understanding 2 – Pineapple

Consolidated statement of profit or loss for the year ended 30 September 20X3

	$000
Continuing operations
Revenue	12,953
($9,854 + $3,562 – $400 (intra. co) – $63 (W1))
Cost of sales	(7,213)
($5,432 + $2,139 – $400 (intra. co) + $42 (W2))
	––––––
Gross profit	5,740
Administrative expenses	(2,147)
($1,432 + $400 + $15 (W3) + $300 GW imp.)
Distribution costs	(726)
($402 + $324)
	––––––
Profit from operations	2,867
Share of profit of associates (W4)	54
Investment income	195
($386 + $15 – $320 (W5) + $114 (W6))
Finance costs	(793)
($246 + $547 (W6))
	––––––
Profit before taxation	2,323
Taxation	(386)
($486 – $100 (W7))
	––––––
Profit for the period from continuing operations	1,937

Discontinued operations
Profit for the period from discontinued operations (W8)	1,264
	––––––
Total profit for the period	3,201
	––––––
Profit attributable to:
Equity holders of Pineapple (bal. fig.)	3,021
Non-controlling interest (W10)	180
	––––––

3,201

––––––

Group structure

Revenue

A total price of $72,000 ($3,000 × 24) should be allocated to the performance obligation to provide technical support. This should be recognised as revenue over time.

Only 3 months of the service period have passed, therefore 21 months of service revenue must be removed from Pineapple’s statement of profit or loss.

This amounts to $63,000 (21 months × $3,000 per month).

(W2) Excess depreciation

The carrying amount of the net assets acquired is $2,325,000 ($1,000,000 + $1,325,000).

The excess of the fair value over the carrying amount is therefore $1,675,000 ($4,000,000 – $2,325,000).

The extra depreciation required is $42,000 ($1,675,000/40 years).

(W3) Pensions

Pineapple is obliged to pay $45,000 ($900,000 × 5%) in the current year. It has currently paid $30,000. An accrual is required for $15,000 ($45,000 – $30,000).

(W4) Share of profit of associate
	$000
P’s share of associate’s profit	131
($1,749 × 3/12 × 30%)
P’s share of excess depreciation	(3)
($1,600/40 years × 3/12 × 30%)
Impairment	(50)
PURP	(24)
($100 × 4/5 × 30%)
	––––––
Share of profit of associate	54
	––––––

(W5) Dividends

Strawberry paid a dividend in the year of $400,000 and therefore Pineapple would have received $320,000 ($400,000 × 80%). This should be removed from investment income.

(W6) Financial assets

The financial asset should have been initially recognised at its fair value of $953,000 ($1,500,000 × (1/1.12⁴)).

The asset must be written down by $547,000 ($1,500,000 – $953,000), which will be charged to profit or loss.

The financial asset is measured at amortised cost. Investment income should be recognised at $114,000 ($953,000 × 12%).

(W7) Deferred tax

Strawberry should recognise a deferred tax asset for $100,000

($500,000 × 20%) and should credit tax in profit or loss by the same amount.

(W8) Profit from discontinued operations
	$000
Profit to disposal date	284
($568 × 6/12)
Profit on disposal (W9)	980
	–––––

1,264

–––––

(W9) Profit on disposal of Satsuma

Proceeds from disposal

Carrying amount of subsidiary

Goodwill at disposal

Consideration

NCI at acquisition

FV of net assets at acquisition ($2,000 + $2,045)

Goodwill at acquisition

Impairment (40%)

Net assets at disposal

Share capital

Retained earnings b/fwd

Profit to disposal date (W8)

$000 $000 $000

5,600

4,900

1,600

(4,045)

––––––

2,455

(982)

––––––

1,473

2,000

2,342

284

––––––

4,626

NCI at disposal

NCI at acquisition

NCI share of post-acquisition net

assets

(30% × ($4,626 – $4,045))

NCI share of impairment

(30% × $982)

Carrying amount of sub at disposal

Profit on disposal

(W10) Non-controlling interest

1,600

174

(295)

––––––

(1,479)

––––––

(4,620)

––––––

980

––––––

	$000
NCI % of Strawberry’s profit	163
(20% × ($714 + $100 (W7))
NCI % of Satsuma’s profit to disposal	85
(30% × $284 (W8))
NCI % of Strawberry’s goodwill impairment	(60)
(20% × $300)
NCI % of Strawberry’s excess depreciation	(8)
(20% × $42 (W2))
	–––––

180

–––––

Test your understanding 3 – Vinyl

Consolidated statement of financial position for the Vinyl Group as at 30 September 20X4

	$m
Property, plant and equipment ($350 + MK290/1.7 +	691.6
$160 + $11 (W2))
Goodwill ($90.6 + $3.2 (W3))	93.8
Other intangible assets (MK10/1.7 (W2))	5.9
Investment properties ($10 + $4)	14.0
Financial assets ($21 + $3.1 – $1.3 – $0.2 (W11))	22.6
	–––––
	827.9
Inventories ($49 + MK45/1.7 + $37)	112.5
Trade receivables ($76 + MK46/1.7 + $49)	152.05
Cash and cash equivalents ($52 + MK38/1.7 + $23)	97.35
	–––––
Total assets	1,189.8
	–––––
Share capital	65.0
Other components of equity (W5)	76.8
Retained earnings (W5)	572.7
Translation reserve (W6)	(88.8)
	––––––
	625.7
Non-controlling interest (W4)	96.4
	––––––
Non-current liabilities	722.1
Non-current liabilities
Loans ($200 – $6.3 (W10) + MK15/1.7 + $24)	226.5
Defined benefit pension deficit (W9)	59.0
Current liabilities ($92 + MK53/1.7 + $59)	182.2
	––––––
	1,189.8
	––––––

Workings

(W1) Group structure

(W2) Net assets
	Acquisition	Reporting date
CD	MKm	MKm
CD
Share capital	76	76
Retained earnings	210	275
Brand (bal. fig)	10	10
	––––––	––––––
	296	361
	––––––	––––––

	Acquisition	Reporting date
Tape	$m	$m
Tape
Share capital	79	79
Other components	1	6
Retained earnings	19	101
Land (bal. fig.)	11	11
	––––––	––––––
	110	197
	––––––	––––––

(W3) Goodwill
CD			MKm
Consideration			360.0
FV of NCI at acquisition			90.0
FV of net assets at acquisition (W2)			(296.0)
			––––––
Goodwill			154.0
			––––––
	MKm	Exchange Rate	$m
Opening goodwill	154.0	1.2	128.3
Exchange loss	–	Bal fig.	(37.7)
	––––––		––––––
Closing goodwill	154.0	1.7	90.6
	––––––		––––––

The total exchange loss of $37.7m will be allocated to the group and

NCI based on their respective shareholdings:

Group: $37.7m × 75% = $28.3m

NCI: $37.7m × 25% = $9.4m

Tape	$m
Consideration	100.0
NCI at acquisition	22.0
(20% × $110 (W2))
FV of net assets at acquisition (W2)	(110.0)
	––––––
Goodwill at acquisition	12.0
Impairment (W7)	(8.8)
	––––––
Goodwill at reporting date	3.2
	––––––

	(W4) Non-controlling interest
		$m
	NCI in CD at acquisition	75.0
	(MK90/1.2 (W3))
	NCI % of CD’s post acquisition net assets	11.6
	25% × (MK361 – MK296 (W2)/1.4)
	NCI % of forex on CD’s goodwill (W3)	(9.4)
	NCI % of forex on CD’s opening net assets and profit (W8)	(20.2)
	NCI in Tape at acquisition (W3)	22.0
	NCI % of Tape’s post-acquisition net assets	17.4
	20% × ($197 – $110) (W2)	––––
		––––
		96.4
		––––
	(W5) Group reserves
	Retained earnings
		$m
	100% Vinyl	501.0
	Vinyl % of CD’s post-acquisition retained earnings	34.8
	75% × (MK361 – MK296 (W2)/1.4)	65.6
	Vinyl % of Tape’s post-acquisition retained earnings	65.6
	80% × (($197 – $110) – ($6 – $1))	(8.8)
	Goodwill impairment (W7)	(8.8)
	Investment property gain ($14 – $10)	4.0
	Net interest component (W9)	(3.5)
	Service cost (W9)	(22.0)
	Financial asset – effective interest (W11)	3.1
	Financial asset – interest received (W11)	(1.3)
	Loss allowance (W11)	(0.2)
		––––
		572.7
		––––

Other components of equity
	$m
100% Vinyl	50.0
Vinyl % of Tape’s post-acquisition other components of equity	4.0
80% × ($6 – $1) (W2)	16.5
Remeasurement gain (W9)	16.5
Convertible bond (W10)	6.3
	––––
	76.8
	––––
(W6) Translation reserve
	$m
Vinyl % of forex on CD’s goodwill (W3)	(28.3)
Vinyl % of forex on CD’s opening net assets and profit (W8)	(60.5)
	––––
	(88.8)
	––––
(W7) Goodwill impairment – Tape
	$m
Year-end net assets (W2)	197.0
Goodwill (W3)	12.0
Notional NCI ($12 × 20/80)	3.0
––––––
	212.0
Recoverable amount	(201.0)
––––––
Impairment	11.0
––––––

The impairment loss is allocated to the group based on shareholding.

The impairment loss attributable to the group is therefore $8.8m

($11m × 80%). The goodwill attributable to the NCI is not recognised

under the share of net assets method. Therefore the NCI share of the

impairment is not recognised.

(W8) Forex on opening net assets and profit
	MKm	Exchange Rate	$m
Opening net assets (W2)	296.0	1.2	246.7
Profit (W2)	65.0	1.4	46.4
Exchange loss	–	Bal fig.	(80.7)
	––––––		––––––
Closing net assets	361.0	1.7	212.4
	––––––		––––––

The forex loss is split between the group and the NCI based on their respective shareholdings:

Group: $80.7m × 75% = $60.5m

NCI: $80.7m × 25% = $20.2m

(W9) Pension
	$m
Net deficit b/fwd ($50 + $20)	70.0
Net interest component ($70 × 5%)	3.5
Cash contributions	(20.0)
Service cost	22.0
Benefits paid out	–
Remeasurement gain (bal. fig.)	(16.5)
	––––––
Net deficit c/fwd ($179 – $120)	59.0
	––––––

The cash contributions have already been accounted for. Therefore, the following adjustments are required:

Net interest
Dr profit or loss	$3.5m
Cr Net pension deficit	$3.5m
Service cost
Dr profit or loss	$22.0m
Cr Net pension deficit	$22.0m
Remeasurement gain
Dr Net pension deficit	$16.5m
Cr Other comprehensive income	$16.5m

(W10) Convertible bond

The convertible bond should have been split into a liability component and an equity component. The liability component is calculated as the present value of the repayments, discounted using the interest rate on a similar debt instrument without a conversion option. The equity component is the balance of the proceeds.

The repayments are interest of $2m (500,000 × $100 × 4%) per year, plus the repayment of $50m (500,000 × $100) on 30 September 20X7.

Date	Cash flow	Discount rate	Present value
	$m		$m
30/9/X5	2.0	1/1.09	1.8
30/9/X6	2.0	1/1.09²	1.7
30/9/X7	52.0	1/1.09³	40.2
			––––––
Liability			43.7
			––––––

The liability component is initially recognised at $43.7m so the equity component is recognised at $6.3m ($50m – $43.7).

The following adjustment is required:
Dr Loans	$6.3m
Cr Other components of equity	$6.3m

(W11) Financial assets

Interest should have been charged using the effective rate.

Investment income in profit or loss should be $3.1m ($21m × 14.6%). The interest received of $1.3m should be removed from profit or loss and deducted from the carrying amount of the financial asset.

The loss allowance will reduce the net carrying amount of financial assets and is charged to profit or loss.

	The entries required are:
	Effective interest
	Dr Financial asset	$3.1m
	Cr Profit or loss	$3.1m
	Interest received
	Dr Profit or loss	$1.3m
	Cr Financial asset	$1.3m
	Loss allowance
	Dr Profit or loss	$0.2m
	Cr Loss allowance	$0.2m

Test your understanding 4 – Frank

Consolidated statement of cash flows
	$m	$m
Cash flows from operating activities
Profit before tax	88
Finance cost	12
Profit on disposal of subsidiary	(3)
Share of profit of associates	(21)
Depreciation	52
Loss on disposal of PPE ($10 – $12)	2
Impairment of goodwill (W1)	27
Gain on investment properties (W2)	(8)
Increase in inventories	(55)
($256 – $201)
Reduction in receivables	12
($219 – $263 + $32)
Increase in payables	91
(($524 – $2 PPE accrual) – $486 + $55)
	–––––
Cash generated from operations	197
Interest paid ($12 – $2 forex loss)	(10)
Taxation paid (W3)	(7)
	–––––
Net cash from operating activities		180

Cash flows from investing activities
Purchase of PPE (W4)	(54)
Proceeds from disposal of PPE	10
Cash grant received	3
Purchase of investment properties	(14)
Dividends received from associate (W5)	17
Purchase of associates	(65)
Net cash impact of subsidiary disposal	35
(W6)
	–––––
Net cash from investing activities	(68)
Cash flows from financing activities
Proceeds from share issue ($122 – $102)	20
Proceeds from loan issue (W7)	39
Dividends paid (W8)	(4)
Dividends paid to NCI (W9)	(15)
	–––––

Net cash from financing activities

Increase in cash and cash equivalents

Opening cash and cash equivalents

($42 – $148)

Closing cash and cash equivalents

($103 – $57)

–––––

152

(106)

–––––

Workings
(W1) Goodwill
	$m
Bal b/fwd	142
Disposal of subsidiary	(40)
Impairment in year (bal. fig.)	(27)
	––––––
Bal c/fwd	75
	––––––

(W2) Investment properties
	$m
Bal b/fwd	60
Additions	14
Gain in P/L (bal. fig.)	8
	––––
Bal c/fwd	82
	––––
(W3) Taxation
	$m
Bal b/fwd ($33 + $12)	45
P/L	19
OCI	10
Cash paid (bal. fig)	(7)
	––––
Bal c/fwd ($44 + $23)	67
	––––
(W4) Property, plant and equipment
	$m
Bal b/fwd	263
Depreciation	(52)
Disposal of subsidiary	(81)
Disposal of PPE	(12)
Revaluation of PPE	50
Grant	(3)
Additions (bal. fig)	56
	––––
Bal c/fwd	221
	––––

Total PPE additions are $56m but $2m of this is included in payables and therefore has not been paid. This means that cash additions are $54m ($56m – $2m).

(W5) Associates
		$m
Bal b/fwd		103
Share of profit		21
Fair value of Chip retained		32
Additions		65
Dividends received (bal. fig)		(17)
		––––
Bal c/fwd		204
		––––
(W6) Disposal of subsidiary
	$m	$m
Cash proceeds (bal. fig.)		41
FV of interest retained		32
Goodwill at disposal	40
Net assets at disposal	34
NCI at disposal	(4)
CA of subsidiary at disposal	––––	(70)
CA of subsidiary at disposal		(70)
		––––
Profit on disposal (per P/L)		3
		––––

At the disposal date, the subsidiary had cash and cash equivalents of $6m. The net cash impact of the disposal is therefore $35m ($41m – $6m).

(W7) Loans
	$m
Bal b/fwd	152
Disposal of subsidiary	(30)
Foreign exchange loss	2
Proceeds from loan issue (bal. fig.)	39
	––––
Bal c/fwd	163
	––––

	(W8) Retained earnings
		$m
	Bal b/fwd	24
	Profit attributable to equity holders	43
	Reserve transfer	1
	Dividend paid (bal. fig.)	(4)
		––––
	Bal c/fwd	64
		––––
	(W9) Non-controlling interest
		$m
	Bal b/fwd	87
	Subsidiary disposal	(4)
	Total comprehensive income	36
	Dividend paid (bal. fig.)	(15)
		––––
	Bal c/fwd	104
		––––
	(W10) Other components of equity (for proof only)
		$m
	Bal b/fwd	30
	Group share of other comprehensive income	30
	($73 TCI share – $43 profit share)
	Reserve transfer	(1)
		––––
	Bal c/fwd	59
		––––

Test your understanding 5 – Sunny Days

Biological assets

Unconditional government grants related to biological assets are recognised in profit or loss when they become receivable. The government grant of $0.2 million will be recognised immediately in profit or loss because it was unconditional.

At the reporting date, biological assets are remeasured to fair value less costs to sell with gains or losses reported in profit or loss. Fair value is defined as the price that would be received from selling an asset in an orderly transaction amongst market participants at the measurement date. Fair value is determined by reference to the principal market or, in the absence of a principal market, the most advantageous market. The most advantageous market is the market which maximizes the net selling price that an entity will receive.

The principal market cannot be determined so the fair value of the biological assets at year end must be determined with reference to the most advantageous market. The net price received in market 1 is $2.49 million ($2.6m – $0.1m – ($2.6m × 0.5%)). The net price received in market 2 is $2.39 million ($2.8m – $0.4m – ($2.8m ×

0.5%)). Market 1 is the most advantageous market and should be used to determine fair value.

The fair value of the herd is therefore $2.5 million ($2.6m – $0.1m) and the fair value less costs to sell is $2.49 million (see calculation above). The herd should be recognized at $2.49 million at the reporting date and a gain of $0.39 million (W1) will be recorded in profit or loss.

Land

The land is an item of property, plant and equipment. Revaluation losses on property, plant and equipment are recorded in profit or loss unless a revaluation surplus exists for that specific asset.

The revaluation on 30 September 20X3 of $0.2 million ($3.2m – $3.0m) would have been recorded in other comprehensive income and held within a revaluation reserve in equity. The downwards revaluation in the current reporting period is $0.5 million ($3.2m – $2.7m). Of this, $0.2 million will be charged to other comprehensive income and the remaining $0.3 million will be charged to profit or loss.

(W1) Gain on revaluation of biological assets
	$m
Bfd	1.8
Additions	0.8
Death and disposal	(0.5)
Gain	0.39
	–––––
Cfd	2.49
	–––––

To recognise a provision, IAS 37 Provisions, Contingent Liabilities and Contingent Assets says that the following criteria must be satisfied:

– There must be a present obligation from a past event

– There must be a probable outflow of economic benefits

– The costs to settle the obligation must be capable of being estimated reliably.

No provision should be recognised for the $0.8 million costs of compliance because there is no obligation to pay (Sunny Days could simply change the nature of its business activities).

A provision should be made for the $0.1 million fine because there will be a probable outflow of resources from a past obligating event (breaking the law).

The fine is not an allowable expense for tax purposes and so the difference between accounting and tax treatments is not temporary. This means that no deferred tax balance is recognised.

A contract contains a lease if it ‘conveys the right to control the use of an identified asset for a period of time in exchange for consideration’ (IFRS 16, para 9).

To assess whether this is the case, IFRS 16 Leases requires entities to consider whether the customer has:

– the right to substantially all of the identified asset’s economic benefits, and

– the right to direct the identified asset’s use.

An asset – Unit 5A – is explicitly identified in the contract. Although Sunny Days can be relocated to a different unit, the supplier is unlikely to benefit from this. Therefore Sunny Days has the right to use an identified asset over the contract term.

Sunny Days has the right to substantially all of the economic benefits resulting from the use of the unit. This is because it has exclusive use of Unit 5A for five years, enabling it to make sales and to generate profits. The payments made to the supplier based on the revenue generated are a form of consideration that is transferred in exchange for the right to use the unit.

Sunny Days has the right to direct the use of the unit because it decides what products are sold, and the price at which they are sold. The restrictions on opening times outlined in the contract define the scope of a Sunny Day’s right of use, rather than preventing Sunny Days from directing use. The supplier’s provision of security and maintenance services have no impact on how Unit 5A is used.

Based on the above, it would seem that the contract between Sunny Days and its supplier contains a lease.

Test your understanding 6 – Coffee

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors says that a prior period error is a misstatement in prior year financial statements resulting from the misuse of information which should have been taken into account. Prior period errors are adjusted for retrospectively, by restating comparative amounts. Changes in accounting estimates are accounted for prospectively by including the impact in profit or loss in the current period and, where relevant, future periods.

The court case

This is not a prior period error because Coffee had based its accounting treatment on the best information available. The payment of $2 million will be expensed to profit or loss in the year ended 30 September 20X4.

Tax

The mistakes made in the financial statements for the year ended 30 September 20X3 should not have been made based on the information available to Coffee. This therefore satisfies the definition of a prior period error. In the financial statements for the year ended 30 September 20X3 the current tax expense and the income tax payable should both be increased by $1 million.

According to IFRS 9 Financial Instruments, an investment in debt should be held at amortised cost if it passes the ‘contractual cash flows characteristics’ test and if an entity’s business model is to hold the asset until maturity. The contractual cash flows characteristics test is passed if the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

If an entity’s business model is to both hold the assets to maturity and to sell the assets, and the asset passes the contractual cash flows characteristics test, then the debt instrument should be measured at fair value through other comprehensive income. All other investments in debt instruments should be measured at fair value through profit or loss.

Coffee’s individual financial statements

Coffee regularly sells the financial assets, and therefore does not hold them in order to collect the contractual cash flows. In Coffee’s individual financial statements, the financial assets should be measured at fair value at the reporting date with any gains or losses reported in profit or loss.

Consolidated financial statements

IFRS 10 Consolidated Financial Statements says that group accounts show the incomes, expenses, assets and liabilities of a parent and its subsidiaries as a single economic entity. Any profit or loss arising on the sale of the assets between Coffee and Tea must be eliminated when producing the consolidated financial statements.

Tea holds the financial assets until maturity. Therefore, the financial assets are held within the Coffee group in order to collect the contractual cash flows. In the consolidated financial statements of the Coffee group, the financial assets should be measured at amortised cost. Assuming that credit risk is low at the reporting date, a loss allowance must be created equal to 12-month expected credit losses.

The group could designate the financial assets to be measured at fair value through profit or loss if it reduces an accounting mismatch that arises from recognising gains or losses on different bases.

IAS 7 Statement of Cash Flows defines ‘cash equivalents’ as ‘short-term, highly liquid investments that are readily convertible to a known amount of cash and which are subject to an insignificant risk of a change in value’ (IAS 7, para 6).

The gold bullion is held for investment purposes, not for the purpose of meeting short-term cash commitments. There is also a substantial risk that the gold will go up or down in value and therefore it is not convertible to a known amount of cash. The gold bullion must therefore be excluded from cash and cash equivalents in the statement of cash flows. The money spent on the gold bullion would most likely be presented within cash flows from investing activities.

Purchased intangible assets are initially measured at cost. The customer list will therefore be initially recognised at its cost of $2 million.

Expenditure on internally generated intangible assets (except those arising from development activities) cannot be distinguished from the cost of developing the business as a whole. Such items are not recognised as intangible assets. The enhancement to the list is internally generated and consequently cannot be recognised.

Intangible assets can only be held under a revaluation model if an active market exists. The customer list is bespoke and so no active market will exist. Therefore, it cannot be held at fair value.

The customer list should be amortised over its estimated useful life of 18 months. This is the period over which the benefits of the $2 million expenditure will be realised. The amortisation expense in profit or loss in the current period is $1.3 million ($2m × 12/18) and the carrying amount of the intangible at the reporting date is $0.7 million ($2m – $1.3m).

Test your understanding 7 – Bath

According to IFRS 8 Operating Segments, an entity must report information about an operating segment if its:

– total revenue (internal and external) is 10% or more of the combined revenue of all segments

– reported profit or loss is more than 10% of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined reported loss of all operating segments that reported a loss, or

– assets are 10% or more of the combined assets of all operating segments.

If total external revenue reported by operating segments is less than 75% of the entity’s total revenue, additional operating segments must be identified as reportable.

Revenue

All segments with total revenue of greater than $60.9 million (10% × $609m) must be reported.

Delivery Services and Vehicle Hire pass this test.

Reported profit or loss

The total profit of the profit making segments is $87 million ($62m + $14m + $8m + $3m). The total loss of the loss making segments is $10 million. 10% of the greater is therefore $8.7 million (10% × $87m). This means that segments with a profit or loss of greater than $8.7 million must be reported.

Delivery Services, Vehicle Hire and Removal Services pass this test.

Assets

All segments with total assets of greater than $49.6 million (10% × $496m) must be reported.

Delivery Services, Vehicle Hire and Removal Services pass this test.

75% test

Based on the above three tests, Delivery Services, Vehicle Hire and Removal Services are reportable. Together, their external revenue is $423 million ($281m + $96m + $46m). This amounts to 93.6% ($423m/$452m) of Bath’s external revenue. Therefore, no other segments need to be reported.

According to IFRS 15 Revenue from Contracts with Customers, an entity should recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service to a customer. Entities must decide at the inception of a contract whether a performance obligation is satisfied over time or at a point in time.

An entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognises revenue over time, if one of the following criteria is met:

– ‘the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs

– the entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced, or

– the entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date’ (IFRS 15, para 35).

The recovery service is consumed as time passes, since the service for a prior month cannot be re-performed again in the future. Revenue should therefore be recognised over time, rather than upfront.

An output method based on the time that has elapsed on the contract would probably provide the best estimate of the amount of revenue to recognise.

Per IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, an asset is classified as held for sale if it is available for immediate sale in its present condition and the sale is highly probable. To be highly probable, there must be an active plan to find a buyer, the asset must be being marketed at a price that is reasonable in relation to its fair value, and the sale should be expected within 12 months. An asset that is classified as held for sale should be measured at the lower of its carrying amount and fair value less costs to sell.

On 30 September 20X4 the sale appeared to be highly probable as the building was being marketed at its fair value. The carrying amount of the asset at 30 September 20X4 was $16 million ($20m × (40/50)). This is lower than the fair value less costs to sell of $16.9 million ($17m – $0.1m). Therefore, the asset should continue to be held at $16m.

The rise in interest rates occurs after the end of the reporting period. Therefore, the decline in the asset’s fair value does not represent conditions that existed at the reporting date. This is a non-adjusting event. The asset will remain classified as held for sale in the financial statements for the period ended 30 September 20X4. The decline in the asset’s value should, however, be described in a disclosure note.

In accordance with IFRS 9 Financial Instruments, financial assets measured at fair value through other comprehensive income are remeasured to fair value each reporting date with the gain or loss recorded in other comprehensive income (OCI).

IFRS 13 Fair Value Measurement defines fair value as the price received when selling an asset in an orderly transaction amongst market participants at the measurement date. When determining fair value, priority is given to level 1 inputs, which are quoted prices for identical assets in active markets. Management’s estimate of the dividends that will be received from the shares is a level 3 input to the fair value hierarchy. This should not be used to determine fair value because a level 1 input exists (a quoted price for an identical asset).

The shares should be revalued to $20 million and a gain of $4 million ($20m – $16m) recognised in OCI. The gain in OCI should be classified as an item that will not be recycled to profit or loss in future periods. The dividend received of $3 million is recognised in profit or loss.

According to IAS 12, deferred tax should be calculated on the difference between the carrying amount of a revalued asset and its tax base, even if there is no intention to dispose of the asset. The temporary difference of $4 million ($20m – $16m) will give rise to a deferred tax liability of $1 million ($4m × 25%). The gain on the investment was recognised in OCI and therefore the deferred tax charge will also be recognised in OCI.

Test your understanding 8 – Arc

(a) Arc – restatement

	Initial	AdjustsNotes		Final
Non-current assets:	$m	$m		$m
Non-current assets:	500			500
Tangible non-current assets	500			500
Cost of investment in Bend	150			150
Cost of investment in Curve	95	(95)	(1)
Loan to Curve		105(2)		105
Current assets	125	105(1)		150
		(105)	(2)
		25(3)
	–––––	–––––		–––––
	870	35		905
Equity and liabilities:	–––––	–––––		–––––
Equity and liabilities:	100			100
Ordinary share capital	100			100
Retained earnings	720	10(1)		755
		25(3)
	–––––	–––––		–––––
Non-current liabilities:	870	35		855
Non-current liabilities:	5			5
Long-term loan	5			5
Current liabilities:	45			45
Trade payables	45			45
	–––––	–––––		–––––
	870	35		905
	–––––	–––––		–––––

Notes:

Disposal of investment in Curve for $105m, resulting in a profit of $10m.

Long-term loan made to Curve.

Dividend due from Bend.

(a) Bend restatement
	Initial	AdjustsNotes		Final
Non-current assets:	$m	$m		$m
Non-current assets:	200	25(3)		225
Tangible non-current assets	200	25(3)		225
Cost of investment in Curve		105(1)		105
Current assets	145	(105)	(1)	15
		(25)	(2)
	–––––	–––––		–––––
	345	–		345
Equity and liabilities:	–––––	–––––		–––––
Equity and liabilities:	100	10(3)		110
Ordinary share capital	100	10(3)		110
Share premium		11(3)		11
Retained earnings	230	(25)	(2)	205
	–––––	–––––		–––––
Non-current liabilities:	330	(4)		326
Non-current liabilities:		4(3)		4
Long-term loan		4(3)		4
Current liabilities:	15			15
Trade payables	15			15
	–––––	–––––		–––––
	345	–		345
	–––––	–––––		–––––

Notes:

Purchase of investment in Curve for $105m.

Dividend due to Arc.

Purchase of land and buildings from Curve – comprising:

	$m
Non-voting shares of $1 each	10
Share premium (bal fig)	11
Mortgage liability taken over	4
	–––––
	25
	–––––

3 – Lease obligation as follows:

	Bal b/fwd	Int @ 10.2%	Cash paid	Bal c/fwd
	$000	$000	$000	$000
Y/end 30/06/X1	3,000	306	(700)	2,606
Y/end 30/06/X2	2,606	266	(700)	2,172

Current liability element = $2,606,000 – $2,172,000 = $434,000

(a) Curve – restatement

Non-current assets:

Tangible non-current assets

Lease assets

Cost of investment in Bend Current assets

Equity and liabilities:

Ordinary share capital

Share premium

Retained earnings

Non-current liabilities:

Long-term loan

Loan from Arc

Lease obligation

Initial	AdjustsNotes	Final
$m	$m	$m
55	(15.0)(2)	40.0
	3.0(3)	2.5
	(0.5)(3)
	21.0	21.0
25	105.0(1)	129.3
	(0.7)(3)
–––––	–––––	–––––
80	112.8	192.8
–––––	–––––	–––––
35		35.0
8		8.0
5	10.0(2)	14.2
	(0.5)(3)
	(0.3)(3)
–––––	–––––	–––––
48	9.2	57.2
12	(4.0)	8.0
	105.0(1)	105.0
	3.0(3)	2.2
	0.3(3)

(0.7)(3)

(0.4)(3)

Current liabilities:		(0.4)(3)	0.4
Lease obligation		(0.4)(3)	0.4
Trade payables	20		20.0
	–––––	–––––	–––––
	80	112.8	192.8
	–––––	–––––	–––––

Notes:

1	– Loan from Arc of $105m.
2	– Sale of land and buildings to Bend as follows:
		$m
	Disposal proceeds (Mort tfr at + shares at FV $21m)	25
	CV of land and buildings	15
		–––
	Profit on disposal	10
		–––

The plan has no impact on the group financial statements as all of the internal transactions will be eliminated on consolidation but does affect the individual accounts of the companies. The reconstruction only masks the problem facing Curve. It does not solve or alter the business risk currently being faced by the group.

A further issue is that such a reorganisation may result in further costs and expenses being incurred. Note that any proposed provision for restructuring must meet the requirements of IAS 37 Provisions, Contingent Liabilities and Contingent Assets before it can be included in the financial statements. A constructive obligation will arise if there is a detailed formal plan produced and a valid expectation in those affected that the plan will be carried out. This is normally crystallised at the point when there is communication by the company with those who are expected to be affected by the plan.

The transactions outlined in the plans are essentially under common control and must be viewed in this light. This plan overcomes the short-term cash flow problem of Curve and results in an increase in the accumulated reserves. The plan does show the financial statements of the individual entities in a better light except for the significant increase in long-term loans in Curve’s statement of financial position. The profit on the sale of the land from Curve to Bend will be eliminated on consolidation.

In the financial statements of Curve, the investment in Bend should be accounted for under IFRS 9. There is now cash available for Curve and this may make the plan attractive. However, the dividend from Bend to Arc will reduce the accumulated reserves of Bend but if paid in cash will reduce the current assets of Bend to a critical level.

The purchase consideration relating to Curve may be a transaction at an overvalue in order to secure the financial stability of the former entity. A range of values are possible which are current value, carrying amount or possibly at zero value depending on the purpose of the reorganisation. Another question which arises is whether the sale of Curve gives rise to a realised profit. Further, there may be a question as to whether Bend has effectively made a distribution. This may arise where the purchase consideration was well in excess of the fair value of Curve. An alternative to a cash purchase would be a share exchange. In this case, local legislation would need to be reviewed in order to determine the requirements for the setting up of any share premium account.

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